In “Value Investing” by James Montier, arguably one of the best books even written about investing, there is a chapter entitled “Maximum Pessimism, Profit Warnings and the Heat of the Moment”. In the chapter, Mr. Montier discusses empathy gaps, which is a bias that causes people to underestimate how we will behave/feel in the future, particularly during moments of stress/emotion; one great example of this is a test performed by Dan Ariely and George Lowenstein at the University of California.
In the experiment, they asked 35 male students to rate how likely they were to find a certain act (spanking, for example) to be sexually stimulating, but under two different scenarios; one was during a routine moment of one’s day, while the other occurred when the subject was at home while enjoying “self-gratification” (for lack of a better term). What the researchers found was that during the light of day, the average rating was 35%; however, when the survey was completed at home, the average rating jumped to 52%.
The purpose of this story is to show that it’s hard to predict how we will act under pressure, in the "heat of the moment"; in the markets, that usually means when the sky is falling. Because of this bias, many will fail to act rationally, resulting in a rare opportunity for intelligent investors; in the words of Sir John Templeton, “The time of maximum pessimism is the best time to buy”.
This brings me to a bit of history that was created on Thursday: Procter & Gamble (PG), the world’s largest consumer products company, issued $1 billion in 10 year bonds at 2.3% this week, the lowest rate ever for 10-year corporate bonds according to Bloomberg. William Larkin, a fixed-income money manager at Cabot Money Management in Massachusetts was quoted in the article as saying, "This is free money.”
For investors buying this offering, they are happily entering into what appears to be a long term disaster; with the CPI running around 3%, they are essentially locking themselves in for a decade of negative real returns (assuming inflation levels remain unchanged). Without looking any further than P&G’s equity, they are also passing up on a company that increased its dividend 9.5% annually for the past half century, and currently yields more than 100 basis points than the fixed rate bond.
In my mind, there is no justification for scooping up 10-year fixed rate bonds, especially when viewed relative to the other ways one can currently build an equity portfolio to generate income and still replicate the benefits (particularly in a state of deflation) generated in a fixed income strategy.
There have been eight recessions (by definition) since 1950, and none of them managed to slow the growth of Procter & Gamble’s first class innovation and products; the same can be said for PepsiCo (PEP), Coca-Cola (KO), Johnson & Johnson (JNJ), and Nestle (NSRGY), among many others. This time isn’t different, even though it may feel as such in the heat of the moment.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.